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Payroll Practices and Procedures Checklist

Author: Alice Gilman

When to Use

At the start of every calendar year, employers are responsible for closing out the prior year's payroll in compliance with all federal, state and local income and employment tax laws, regulations and procedures. They must also be ready to comply with any legal and procedural changes taking effect in the new year and ensure their payroll systems are updated.

To retain control and prevent the process from becoming overwhelming, an orderly and methodical plan of payroll practices and procedures should be mapped out and followed not only at the end and beginning of each year, but throughout the entire year.

Using the following checklist in every pay period and every month (in month order) will help an employer stay in control of payroll responsibilities all year long and easily tackle year-end and new-year challenges.

Year-End 2025 and 2026 Changes

The year-end process for 2025 and into 2026 will challenge employers due to the enactment of the One Big Beautiful Bill Act (OBBBA; 119 P.L. 21) in July 2025. 

FUTA Credit Reduction

In 2020, many states borrowed heavily from the US Department of Labor to pay unemployment benefits during the COVID-19 economic downturn. However, California did not pay back its loan as required by November 10, 2025. Therefore, employers located in California will have higher payroll costs, as their full 5.4% Federal Unemployment Tax Act (FUTA) credit will be reduced by 1.2% for 2025. The additional tax is due with the 2025 Form 940, which must be filed and paid by February 2, 2026 (or February 10, 2026, for employers that have deposited all FUTA taxes on time throughout the year).

Employee Retention Credit

Employers could continue to claim the COVID-19-related Employee Retention Credit (ERC) against wages paid and health benefits provided to qualified employees through September 30, 2021. Although employers were still claiming the ERC for the third and fourth quarter of 2021 through April 2025 on Form 941-X, the OBBBA prevents the IRS from allowing or refunding ERCs after July 4, 2025, for the third and fourth quarters of 2021 if those claims were filed after January 31, 2024. Employers that filed Form 941-X claiming ERCs for the third or fourth quarter of 2021 after January 31, 2024, and received refunds before July 4, 2025, may keep their refunds.

Tips and Overtime

The OBBBA provides employees who earn qualified tips and nonexempt employees who earn federal overtime (i.e., overtime for working longer than 40 hours in a workweek) with above- and below-the-line deductions for these items of income. The IRS clarified that the deductible portion of overtime is the half-time premium. The IRS also released proposed regulations that define who tipped employees are and their occupation codes.

The IRS will not vary the withholding tables for 2026 to account for the tips and overtime deductions. Instead, employees who wish to account for their tips or overtime on a pay period basis will need to complete a 2026 Form W-4, Employee's Withholding Certificate. Employers will need to create pay codes to track employees' tips and the half-time overtime premium, beginning with the first pay period of 2026.

The OBBBA requires employers to report these items on each employee's Form W-2, Wage and Tax Statement, so they know how much to deduct. However, the IRS has granted transition relief for 2025 W-2 reporting, under which employers do not have to report these items in particular but must still report tips in Box 7 and overtime in Boxes 1 - 6.

The IRS, however, has suggested that employers voluntarily report these items to employees. An employer may provide employees with a separate accounting of their qualified tips and the tipped occupation codes (e.g., report tips in Box 7 and the occupation code in Box 14). Likewise, an employer may provide a separate accounting of employees' half-time overtime, use Box 14 of their Forms W-2, post the information to an online portal or use another secure method.

Employers that do not want to report tips or overtime on employees' Forms W-2 can provide separate statements to employees, who will be able to rely on this information as they prepare their 2025 Forms 1040, U.S. Individual Income Tax Return.

Employers may use employees' pay statements and make the following adjustments to report the half-time overtime premium:

  • If employees' pay statements indicate the total amount of overtime at one-and-one half employees' regular rate of pay, that amount is multiplied by one-third. Adjustments may be needed if employees received nondiscretionary bonuses or other payments that must be included in the regular rate;
  • If employees' pay statements indicate their overtime rates exceed 1.5 times their regular rate of pay (e.g., two times their regular rates) and separately account for the portion in excess of their regular rate, that separate amount is multiplied by an appropriate fraction to approximate the half-time premium. If overtime is paid at a rate of two times the regular rate, the appropriate fraction is one-half. Adjustments may be needed if employees received nondiscretionary bonuses or other payments that must be included in the regular rate;
  • If employees' pay statements indicate their overtime rates exceed 1.5 times their regular rate of pay (e.g., two times their regular rates), but shows only the aggregate dollar amount of overtime pay at the rate higher than 1.5 times employees' regular rate, the aggregate dollar amount is multiplied by an appropriately smaller fraction (e.g., if overtime is paid at a rate of two times the regular rate, the appropriate fraction is one-fourth); and
  • If employees do not receive pay statements, the separate statement should include the above elements.

The IRS also noted that employers that want to provide separate statements to employees working under different subsections of section 7 of the Fair Labor Standards Act (e.g., firefighters, law enforcement, public employees who earn compensatory time off in lieu of cash overtime and hospital employees who receive overtime after working longer than eight hours a day or over 80 in a 14-day work period) should base their statements on those separate sections.

Employers that want to provide separate statements to employees who earn tips may tell employees they can rely on the amount reported in Box 7 of their Forms W-2, on the aggregate amount reported on Form 4070, Employee's Report on Tips to Employer, or Form 4137, Social Security and Medicare Tax On Unreported Tip Income. IRS Notice 2025-69. 

The IRS has proposed the following new Box 14 codes for reporting tips and overtime on employees' 2026 Forms W-2:

  • TP - Total amount of cash tips reported to the employer: The employer is not a specified service trade or business;
  • TS - Total amount of cash tips reported to the employer: The employer is a specified service trade or business. Employees cannot use this amount to determine the deduction for qualified tips; and
  • TT - Total amount of qualified overtime compensation.

Benefit Increases for 2026

The OBBBA increases the amount of dependent care benefits an employer may offer to employees on a tax-free basis to $7,500 a year (from $5,000), beginning in 2026. Employers must first amend their dependent care assistance plan before they can offer the increased amount to employees.

The OBBBA makes permanent the IRC § 127 provision that allows employers to pay employees' student loans, up to $5,250 a year. This amount will be inflation adjusted, beginning in 2027.

Information Reporting

The reportable amount for filing Forms 1099-NEC and 1099-MISC increases to $2,000 (from $600), beginning in 2026. This amount also applies to backup withholding. Beginning in 2027, this amount will be inflation adjusted.

Electronic Filing Threshold for Information Returns

The IRS issued final regulations that decreased the mandatory electronic filing threshold for information returns (e.g., Forms W-2, 1095, 1099) to a combined total of 10 or more returns. These regulations also require employers to electronically file corrected returns (e.g., Forms W-2c) if they must electronically file their original returns.

Employers that have never filed Forms W-2 electronically before must first authenticate their identity by establishing accounts with Login.gov or ID.me and then obtain credentials from the Social Security Administration (SSA) by registering with Business Services Online. Employers may no longer log onto BSO through their personal My Social Security accounts.

Regardless of the electronic filing platform, new Form 1099 filers must first authenticate their identity by establishing an account with ID.me and then applying online for an electronic filing credential - a Transmitter Control Code (TCC). Also, to facilitate electronic filing of Forms 1099 by small employers that were never before subject to an electronic filing mandate, the IRS provides a simplified electronic filing platform for Forms 1099 - the Information Returns Intake System (IRIS). IRIS allows employers to key in information and generate the copies they must file and send to recipients. The platform also presents a comma-separated values (csv) template employers can use with spreadsheet programs. The IRS's older electronic filing platform is called the Filing Information Returns Electronically (FIRE) System. 

The IRS will retire FIRE at the end of December 2026. Beginning with 2026 Forms 1099 that are filed in 2027, all filers will use IRIS.

To file Forms 1095, including Forms 1095-B, employers must obtain a separate TCC for the IRS's AIR system.

Since it takes some time for the SSA and the IRS registration processes to be completed, employers are advised to register in the Fall.